The OECD has issued the final implementation guidance for pillar two of the BEPS 2.0 initiative, paving the way for the implementation of a global minimum tax rate of 15 percent in 2024. Both mainland China and Hong Kong have agreed to the minimum tax rate and associated rules, which means some multinationals in China may be required to pay top-up taxes in the future. We discuss the latest OECD rules and the potential impact of the China BEPS 2.0 framework on multinationals.
The Organization for Economic Cooperation and Development (OECD) has released the Agreed Administrative Guidance for the Pillar Two GloBE Rules (the “Agreed Administrative Guidance”). These are a set of administrative guidelines for members of the “OECD/G20 Inclusive Framework on BEPS” to implement the Global Anti-Base Erosion (GloBE) Rules, which make large multinational enterprises (MNEs) liable for a minimum corporate income tax (CIT) rate of 15 percent on the income arising in each of the jurisdictions in which they operate. This initiative is commonly referred to as BEPS 2.0.
The Agreed Administrative Guidance is the final piece of guidance that the OECD will release for the implementation of the “Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy” (the “Two Pillar Solution”), and therefore marks the completion of the framework for implementation in 2024.
The OECD/G20 Inclusive Framework on BEPS (which stands for “base erosion and profit shifting”), more commonly referred to as the “Inclusive Framework” (IF), is an initiative by the OECD and the G20 to tackle the practice whereby MNEs avoid paying taxes by declaring profits in a low-tax jurisdiction. According to the OECD, BEPS practices cost countries around US$100 billion to US$240 billion in lost revenue annually, equivalent to around 4 to 10 percent of the global CIT revenue.
Both mainland China and Hong Kong have agreed to the Two Pillar Solution and GloBE Rules, committing to reforming the international tax framework and tackling tax evasion by MNEs. This includes making changes to domestic tax regulations in order to meet the minimum 15 percent CIT rate.
What are the “two pillars” of BEPS 2.0?
On October 8, 2021, the OECD released the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (commonly referred to as the “October Statement”), which provides a detailed implementation plan for the implementation of the two-pillar solution and a timeline for the implementation process and the formulation of more rules for the two pillars.
The October Statement was based upon a previous statement released in July 2021, which outlined the components of the two-pillar solution that had been agreed upon by a portion of the IF members.
As of December 16, 2022, 138 out of the 142 IF members had agreed to the October Statement, including both mainland China and Hong Kong.
As outlined in the July and October statements, the BEPS 2.0 package consists of two parts, or the “two pillars”:
- Pillar One – focused on profit allocation and nexus, requiring MNEs to pay taxes in the countries where they have users, even if they have no commercial presence there.
- Pillar Two – focused on a global minimum tax rate of 15 percent targeting large MNEs with global turnover above €750 million.
What are the GloBE Rules?
On December 20, 2021, the OECD released the Pillar Two model rules (also known as the “GloBE Rules”) for the domestic implementation of the 15 percent global minimum tax. These rules assist governments with the implementation of the Pillar Two Solution, define the MNEs within the scope of the minimum tax rate, and set out mechanisms for calculating MNEs’ effective tax rate and determining the amount of top-up taxes payable. It also covers matters such as mergers and acquisitions, operative rules, rules on transition periods, and more.
The GloBE Rules only apply to MNEs with a global turnover of at least €750 million. It does not apply to companies that have no foreign presence, government entities, international and non-profit organizations, or entities that meet the definition of a pension, investment, or real estate fund.
The MNEs that fall within the scope of the GloBE Rules are required to calculate their effective tax rate for each jurisdiction in which they have operations and, in the event that the tax rate falls below 15 percent in any jurisdiction, pay top-up tax to make up the difference. This top-up tax is generally paid by the “ultimate parent company” of the MNE in the jurisdiction in which the parent company is based. This is known as the Income Inclusion Rule (IIR). Under this rule, the parent company is required to pay the top-up taxes in proportion to its ownership interests in those entities that have low tax income.
In order for an MNE to calculate its effective tax rate, it will need to collect the necessary information from its subsidiaries (or constituent entities) at the group level. As this kind of information is normally maintained in the different operation systems of the various subsidiaries, it will now need to be captured by the group-level ERP system or consolidated into a specialized database for the purpose of complying with the GloBE Rules.
In addition to the requirements for calculating an MNEs effective tax, there is a variety of other assessment and information reporting requirements, such as those outlined in Chapter 8 of the GloBE Rules and the GloBE Information Return rules. This information can also be captured by the same centralized ERP system or database in order to ensure compliance.
If an entity is not subject to IIR, then the jurisdiction can implement the Undertaxed Payment Rule (UTPR) as a backstop. Under the UTPR, the company that is a member of an MNE is required to make an adjustment “in respect of any top-up tax that is allocated to that taxpayer from a low-tax Constituent Entity of the same group”. This top-up tax is normally collected through “a denial of a deduction for any deductible expense (or an equivalent adjustment under domestic law)”, according to an OECD factsheet.
The “ultimate parent company” is defined in the rules as “an Entity that […] owns directly or indirectly a Controlling Interest in any other Entity; and […] is not owned, with a Controlling Interest, directly or indirectly by another Entity”.
What is the new Agreed Administrative Guidance?
The new Agreed Administrative Guidance provides guidance for jurisdictions to implement Pillar Two. As stated by the OECD, they will “ensure coordinated outcomes and greater certainty for businesses as they move to apply the global minimum corporate tax rules from the beginning of 2024”.
The Agreed Administrative Guidance is the final piece of guidance for the implementation of the Two Pillars Solution. Other guidelines that have been released include:
- The Safe Harbours and Penalty Relief document, released in December 2022, agrees upon a transitional safe harbor for MNEs, as well as a regulatory framework for the development of a potential permanent safe harbor.
- Public consultation document on the GloBE Information Return, open for consultation from December 20, 2022 to February 3, 2023, outlines the type of information that MNEs will have to disclose in order for the tax authorities to evaluate their tax liability.
- Public consultations on Tax Certainty, open for consultation from December 20, 2022, to February 3, 2023, outline the various mechanisms for achieving tax certainty, such as dispute prevention and dispute resolution mechanisms, among others. “Tax certainty” refers to the creation of a transparent and robust tax regulatory environment that fosters mutual trust between companies, tax authorities, and other stakeholders.
By agreeing to the Agreed Administrative Guidance, the IF members have agreed to “apply the GloBE Rules consistent with Agreed Administrative Guidance, subject to any requirements of domestic law” (in this instance, the “Agreed Administrative Guidance” is defined as “guidance issued by the Inclusive Framework on either ‘the interpretation or administration of the GloBE Rules’”, and not exclusively the Agreed Administrative Guidance discussed in this article).
How will the GloBE Rules impact mainland China and Hong Kong?
As mentioned, the BEPS 2.0 package will require members that have agreed to the rules to make amendments to domestic laws in order to ensure MNEs pay the minimum 15 percent CIT rate and are liable for tax on operations conducted within their jurisdictions. The degree to which the local laws will have to be altered will depend on how much their existing laws already align with the requirements in the GloBE Rules and other documents.
For mainland China, this may only require minor adjustments. Mainland China’s standard CIT rate is 25 percent, however, certain industries in certain jurisdictions are eligible for a lower CIT rate of 15 percent. Although this still meets the BEPS 2.0 threshold, various additional tax incentives may put a company’s CIT rate below 15 percent. These jurisdictions will therefore have to ensure that the MNEs that do not meet the threshold for BEPS 2.0 pay top-up taxes to ensure they hit the 15 percent minimum.
Meanwhile, many large Chinese MNEs, such as Baidu, Alibaba, and Tencent, are incorporated in low-tax overseas jurisdictions, such as the Cayman Islands. As the Cayman Islands are also a member of the IF and have agreed to the BEPS 2.0 rules, these companies will have to pay top-up taxes if they declare profits in this jurisdiction.
For Hong Kong, the situation is similar, although the scope of companies that will be affected will be broader. Hong Kong’s standard CIT rate, at 16.5 percent, is above the BEPS 2.0 threshold, but with the various tax incentives available, many companies pay CIT rates of below 15 percent and will be required to pay top-up taxes.
Both mainland China and Hong Kong will have to formulate regulations in line with the GloBE Rules to ensure the constituent entities of MNEs whose tax payable falls below the 15 percent threshold pay top-up taxes in the respective jurisdictions.
What are the next steps for IF members and the OECD?
The OECD had initially set the launch of the BEPS 2.0 rules for 2023. However, following continued discussions and disagreements over the details of the rules, the implementation has been delayed until 2024. In line with this, Hong Kong’s Secretary for Financial Services and the Treasury announced in August that it would delay the implementation of the IIR to 2024 “at the earliest”, suggesting it could be further delayed.
Despite some skepticism over the timeframe, the finalization of the BEPS 2.0 rules and implementation guidance marks an important milestone for the realization of Pillar Two of the BEPS 2.0. Meanwhile, in late 2022, the EU unanimously agreed to a directive ensuring the global minimum tax. As part of the directive, EU member countries have agreed to add the rules into domestic law by December 31 and start implementation of IIR for fiscal years beginning on or after December 31, 2023. UTPR will be applied for fiscal years beginning on or after December 31, 2024.
Other jurisdictions, such as Canada and Switzerland, have launched a public consultation on the GloBE Rules and domestic minimum top-up tax rules, while the UK has launched a public consultation on an IIR draft, having already clarified the IIR and domestic top-up tax within its jurisdiction last year.
Meanwhile, the US is considering whether to change its global intangible low-taxed income (GILTI) rules to the 15 percent minimum tax rate and country-by-country calculation and country-by-country calculation, but this has not yet been implemented.
Although the Agreed Administrative Guidance is the final piece of implementation guidance for IF members, the OECD acknowledges there is more work to be done in the coming year before implementation. This will include ensuring the coordinated implementation of the rules over the next year, as well as soliciting further feedback from stakeholders in order to further refine the rules and achieve “better tax certainty”.
Although the Agreed Administrative Guidance is the final piece of implementation guidance for IF members, the OECD acknowledges they will continue to work in the coming year before implementation. This will include ensuring the coordinated implementation of the rules over the next year, as well as soliciting further feedback from stakeholders in order to further refine the rules and achieve “better tax certainty”.
In the statement released along with the Agreed Administrative Guidance, the OECD said that the guidance will be incorporated into an updated commentary (interpretation guidelines to the GloBE Rules) later in 2023, replacing the original version released in March 2022. In addition, the IF will “continue to release further Agreed Administrative Guidance on an ongoing basis, to ensure that the GloBE Rules continue to be implemented and applied in a coordinated manner”.
China Briefing is written and produced by Dezan Shira & Associates. The practice assists foreign investors into China and has done so since 1992 through offices in Beijing, Tianjin, Dalian, Qingdao, Shanghai, Hangzhou, Ningbo, Suzhou, Guangzhou, Dongguan, Zhongshan, Shenzhen, and Hong Kong. Please contact the firm for assistance in China at email@example.com.
Dezan Shira & Associates has offices in Vietnam, Indonesia, Singapore, United States, Germany, Italy, India, and Russia, in addition to our trade research facilities along the Belt & Road Initiative. We also have partner firms assisting foreign investors in The Philippines, Malaysia, Thailand, Bangladesh.